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access to finance

Can Financial Deepening Reduce Poverty? Evidence from Sub-Saharan Africa

Raju Jan Singh's picture

Editor's Note: Raju Jan Singh recently presented the findings of the paper discussed in the following blog post at a session of the FPD Academy. Please see the FPD Academy page on the All About Finance blog for more information on this monthly World Bank event.

The recent financial crisis has renewed concerns about the merits of financial development, especially for the most vulnerable parts of the population. While financial development and its effects on economic growth have attracted much attention in the literature, far less work has been done on the relationship between financial deepening and poverty. Yet some economists have argued that lack of access to finance is among the main causes of persistent poverty.

Studies on the relationship between financial development and income distribution have been inconclusive. Some claim that by allowing more entrepreneurs to obtain financing, financial development improves the allocation of capital, which has a particularly large impact on the poor. Others argue that it is primarily the rich and politically connected who benefit from improvements in the financial system.

Can We Boost Demand for Rainfall Insurance in Developing Countries?

Xavier Gine's picture

Ask small farmers in semiarid areas of Africa or India about the most important risk they face and they will tell you that it is drought. In 2003 an Indian insurance company and World Bank experts designed a potential hedging instrument for this type of risk—an insurance contract that pays off on the basis of the rainfall recorded at a local weather station.

The idea of using an index (in this case rainfall) to proxy for losses is not new. In the 1940s Harold Halcrow, then a PhD student at the University of Chicago, wrote his thesis on the use of area yield to insure against crop yield losses. In the past two decades the market to hedge against weather risk has grown, especially in developed economies: citrus farmers can insure against frost, gas companies against warm winters, ski resorts against lack of snow, and couples against rain on their wedding day.

Rainfall insurance in developing countries is typically sold commercially before the start of the growing season in unit sizes as small as $1. To qualify for a payout, there is no need to file a claim: policyholders automatically qualify if the accumulated rainfall by a certain date is below a certain threshold. Figure 1 shows an example of a payout schedule for an insurance policy against drought, with accumulated rainfall on the x-axis and payouts on the y-axis. If rainfall is above the first trigger, the crop has received enough rain; if it is between the first and second triggers, the policyholder receives a payout, the size of which increases with the deficit in rainfall; and if it is below the second trigger, which corresponds to crop failure, the policyholder gets the maximum payout. This product has inspired development agencies around the world, and today at least 36 pilot projects are introducing index insurance in developing countries.

The Global Financial Inclusion Indicators: An Important Step towards Measuring Access to Finance

Asli Demirgüç-Kunt's picture

How inclusive are financial systems around the world? What proportion of the population uses which financial services? Despite all the work we have done so far, most of the figures cited by experts in this field are still just estimates (see, for example, here and here). But this is about to change—in a big way.

To help us understand the scope and breadth of financial activity by individuals around the world, the Bill & Melinda Gates Foundation today announced an $11 million, 10-year grant to the World Bank’s Development Research Group to build a new publicly accessible database of Global Financial Inclusion Indicators. The ultimate goal of the project is to improve access to finance; achieving this goal requires reliably measuring financial inclusion in a consistent manner over a broad range of countries and over time to provide a solid foundation of data for researchers and policymakers. We will carry out three rounds of data collection, starting with Gallup, Inc’s 2011 Gallup World Poll, which will survey at least 1,000 people per country in 150 countries about their access and use of financial services.

Credit Where Credit is Due: Partial Credit Guarantee Schemes in the Middle East and North Africa

Roberto Rocha's picture

Editor's Note: The following post was submitted jointly by Youssef Hassani, Economist, MENA, Zsofia Arvai, Senior Financial Economist, MENA, and Roberto Rocha, Senior Adviser, MENA.

Many countries in the Middle East and North Africa (MENA) region have established partial credit guarantee schemes (PCGs) to facilitate SME access to finance. These guarantee schemes can potentially play an important role, especially in a period where MENA governments are still making efforts to reduce risks for lenders by improving the effectiveness of credit registries and bureaus and strengthening creditor rights. However, the contribution of credit guarantee schemes to SME finance depends largely on their design. 

Well designed schemes may be able to achieve significant outreach and additionality, i.e. benefit a significant number of SMEs that have substantial growth potential but are effectively credit constrained due to lack of credit information and collateral. In some countries PCGs have also played an important capacity-building role. By contrast, poorly designed guarantees schemes may have a limited development impact by providing guarantees to firms that are not credit constrained. PCGs may also accumulate losses by providing overly generous and underpriced guarantees, and ultimately become a burden to public finances.

Financial Access and the Crisis: Where Do We Stand?

Asli Demirgüç-Kunt's picture

Do you wonder how the recent global crisis affected access to financial services? Well I do, and a report by the World Bank Group and CGAP just provided the answer: Data show that even as countries were suffering because of the financial crisis, access to formal financial services grew in 2009.  Indeed, the number of bank accounts grew world-wide, while at the same time the volume of loans and deposit accounts dropped. The physical outreach of financial systems— consisting of branch networks, automated teller machines (ATMs), and point-of-sale (POS) terminals—all expanded.

That’s a relief. Readers of this blog know by now that I am a strong believer in expanding access. Lack of access to finance is often the critical element underlying persistent income inequality as well as slower growth. But the recent global financial crisis has led us to question many of our beliefs and re-opened old debates. It also exposed an important tension between access and stability. Were we wrong to emphasize access in the light of what happened?

Low Cost Banking: How Retail Stores and Mobile Phones Can Transform Access to Finance

Ignacio Mas's picture

More than 3 billion people in the world today don’t have access to savings accounts. Many of these 3 billion fall below the less-than-$2-per-day benchmark of the world’s poorest people. Why are banks not doing a better job to help them manage their financial lives?

The problem is largely one of cost. Providing financial services to the poor is prohibitively expensive for banks. Each time a client stands in front a of a teller’s window it costs most banks from $1 to $3. If poor clients make transactions of $1 or $2, or even less, banks won’t be able to support the costs.

It’s also too costly for the poor. Most poor people, especially those in rural areas, live far away from bank branches. Let me give one example of a woman in Kenya. The nearest branch may be 10 kilometers away, but it takes her almost an hour to get there by foot and bus because she doesn’t have her own wheels. With waiting times at the branch, that’s a round-trip of two hours – a quarter or so of her working day gone.  While the bus fare is only 50 cents, that’s maybe one fifth of what she makes on an average day. So each banking transaction costs her the equivalent of almost half a day’s wages.

Can the Business Environment Explain International Differences in Entrepreneurial Finance?

Leora Klapper's picture

It is well established that financial development is necessary for the efficient allocation of capital and firm growth, yet firm-level surveys have repeatedly found access to finance to be among the biggest hurdles to starting and growing a new business. For instance, in the World Bank’s Enterprise Surveys standardized dataset for 2006-2009, 31% of firm owners around the world report access to finance as a major constraint to current operations of the firm, while this figure is 40% for firms under three years of age.

In a recent paper with Larry Chavis and Inessa Love we address two types of questions: (1) What is the relationship between firm age and sources of external financing? and (2) Is there a differential impact of the business environment on access to financing by young versus old firms? 

To summarize, we find systematic differences in the use of different financing sources for new and older firms. We find that in all countries younger firms rely less on bank financing and more on informal financing. However, we also find that young firms have relatively better access to bank finance in countries with stronger rule of law and better credit information and that the reliance of young firms on informal finance decreases with the availability of credit information.

Bank Competition and Access to Finance

Asli Demirgüç-Kunt's picture

In a recent blog post, I talked about whether there are trade-offs between bank competition and financial stability.  But what about access to finance?  What does competition imply for access?

Theory supplies conflicting predictions, as usual.  According to standard economic theory, a banking system characterized by market power delivers a lower supply of funds to firms at higher cost; hence greater competition improves access.  However, several theoretical contributions have shown that when we take into account problems of information asymmetry, this relationship may not hold.  For example, banks with greater market power can have more of an incentive to establish long-term relationships with young firms and extend financing since the banks can share in future profits.  In competitive banking markets, however, borrower-specific information may become more dispersed and loan screening less effective, leading to higher interest rates. Indeed, while it has been shown that concentration may reduce the total amount of loanable funds, it may also increase the incentives to screen borrowers, thereby increasing the efficiency of lending.  However, all these models also assume a developed economy, with a high degree of enforcement of contracts and developed institutional environments in general. This is obviously not the case for most of the countries where the Bank works.

How Do Firms Finance Investment?

Asli Demirgüç-Kunt's picture

A large body of literature has found that in countries with weak institutions firms are able to obtain less external financing, resulting in lower growth.  Indeed, even simple cross-country comparisons of firm financing patterns can be quite revealing.  In a paper co-authored with Thorsten Beck and Vojislav Maksimovic, this is exactly what we do.  Using data from the World Bank’s Enterprise Surveys dataset (WBES) for 48 countries, we investigate what proportion of firm investment is financed externally, and, of this external finance, how much of it comes from different sources, such as bank and equity finance, leasing, supplier credit, development banks, and informal sources such as money lenders.

In our sample of firms, on average just over 40 percent of firm investment is externally financed.  Breaking external financing down into its parts, about 19 percent of all financing comes from commercial banks and 3 percent from development banks.  Another 7 percent is provided by suppliers and 6 percent through equity investment.  Leasing is another 3 percent, and less than 2 percent comes from informal sources.  More recent enterprise survey data for an expanded sample of countries and firms also suggest similar patterns (Figure 1).

Sources
Source: Enterprise Surveys, covering 71 countries

Measuring Access to Finance…One Step at a Time

Asli Demirgüç-Kunt's picture

How well do financial systems in different countries serve households and enterprises?  Who has access to which financial services – such as savings, loans, payments, insurance?  Just how limited is access?

Just a short while ago, we didn’t know the answer to these questions.  But modern development theories very much emphasize that broad financial access is the key to development.  Lack of access to finance is often the critical element underlying persistent income inequality as well as slower growth.  Without inclusive financial systems, poor individuals and small enterprises need to rely on their personal wealth or internal resources to invest in their education, become entrepreneurs, and make their businesses grow.  So it was disappointing that although data on the financial sector have been readily available, data on access simply were not.

Those of us who spend our days trying to find ways of influencing policy decisions know that one of the most effective ways of focusing policy attention on an issue is by measurement.  If you can measure something and “benchmark” it with useful comparisons, you are one step closer to identifying what needs to be done.  And if you can provide these measurements at regular intervals, you are more likely to capture the attention of policymakers, promote policy change, and track and evaluate the impact of such policies. A team at the World Bank began thinking about this issue in the beginning of this decade, so when the UN announced 2005 as the Year of Microcredit, we were more than ready to rise to the challenge. 

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